What is a fixed annuity?

A fixed annuity is like a special savings account offered by insurance companies. After contributions are made to an annuity, it returns a guaranteed interest rate on your money for a specified period of time. As a result, it can provide you with a guaranteed stream of income during retirement. Growth is tax-deferred, so you don’t pay taxes on the money until you begin to take withdrawals. 

How does a fixed annuity work?

An annuity is a contract between you and the insurance company. During the accumulation phase, you contribute to the annuity with either a one-time payment or a series of payments over time. The insurance company guarantees to return a specific interest rate, which grows, tax-deferred, in your account. 

At a future date, during what’s called the payout or distribution phase, you receive guaranteed payments for a specified amount of time or until your death, depending on the contract provisions. 

Types of fixed annuities

There are two types of fixed annuities: deferred and immediate. 

Immediate annuities are often chosen by individuals if they are nearing or already in retirement. Soon after making a lump-sum contribution (typically anywhere from 30 days to 12 months), the individual begins to receive distribution payments. Immediate annuities are designed to provide a guaranteed stream of income sooner rather than later. 

Deferred annuities typically collect contributions gradually over time and the payout phase does not occur until years or decades later.

Benefits of a Fixed Annuity

When it comes to fixed annuities, there are a variety of benefits that could fit your retirement needs.

• Tax deferred growth — Annuities are tax-deferred, meaning you don't pay taxes on any growth until you start receiving payments. For many, this can be an attractive benefit for more potential income growth over the long run.* 
  
• Competitive fixed yields — Because fixed annuity rates are set by insurance companies based, in part, on earnings of their own investment portfolios, the rates are often higher than comparable interest-bearing investments, such as certificates of deposit (CDs). 
  
  
• Guaranteed minimum rates — The guaranteed minimum rate of a fixed annuity can help reduce certain risks associated with long-term retirement investments. 
  
  
• Guaranteed income payments — Fixed annuities can provide guaranteed income payments for retirement. Many fixed annuities have flexibility with payouts, as well, with options for a set period of payments to payments that continue for life. 
  
  
• Beneficiary protection — Annuities also provide some protection for your named beneficiary to avoid probate. Depending on the contract, you can either pass on your investment (less any withdrawals) or the contract value should you die before beginning your annuity payout. Death benefits that equal the contract value often come with an additional fee, however. 

Fixed Annuities and Retirement 

Preserving and accumulating capital to carry into retirement is a major concern for millions of Americans. Given there's always a risk with investments due to the fluctuating market, many have considered fixed annuities as an option to help mitigate volatility. 

When looking at your entire financial picture, you — alongside your investment professional — may find that a fixed annuity could potentially help meet your needs or provide a bridge into the next stage of your retirement. 

Keep in mind that since annuities are long-term investments, there are typically tax penalties for withdrawals made by anyone under the age of 59½. It's also important to note that withdrawals can reduce your overall future benefit and value; withdrawals are also subject to income tax. Another very important characteristic of annuities that must be regarded when considering withdrawals is the surrender charge period. During this period, which is often the first 3-10 years of a contract, any withdrawals will be subject to a significant charge. Furthermore, if made before the age of 59½, the aforementioned early withdrawal tax penalty would apply. Most fixed annuities do allow for an annual surrender charge-free withdrawal of 10% of the contract value, however.

Who should consider a fixed annuity? 

Fixed annuities are designed to provide a guaranteed stream of income for retirement. Because they offer a fixed rate of interest that is not tied to market performance, they may be a good option for individuals who are highly risk averse and want to rely on a guaranteed stream of income in retirement. If having a predictable income is more important to you than higher returns on your money, an annuity may be a good option for you. If you’re worried about outliving your savings, an annuity may also be a good option for you, as certain kinds offer guaranteed income up until your death. Here are some examples of individuals who identified fixed vs variable annuities as a part of their retirement strategy. 

Todd is a 49-year-old man who has tucked away savings over the years, but when his wife unexpectedly became ill, he began eating into his savings significantly and is not sure his savings will last for his entire lifetime. He decided to contribute the remainder of his savings to an annuity, which will begin paying out when he is 60, and will provide a guaranteed payout for the remainder of his life.

Mary is a 40 year-old single mom of a special needs child. She knows that her daughter will require care for her entire life. Mary worries about her ability to financially provide for herself and her daughter. She invests in an annuity so that she knows she will have a guaranteed stream of income during her retirement to help pay for her daughter until she passes away, at which time her life insurance coverage will provide funds for her executor to take care of her daughter. 

How do fixed annuities differ from other fixed-income investments?

• Bonds — When you invest in a bond, you lend money to a government or company for a specified period of time in exchange for interest payments. Bonds are more liquid than annuities, returning principal and interest in a shorter timeframe. In addition, bonds are subject to market fluctuations, whereas the interest paid on a fixed annuity is guaranteed, as the risk of market fluctuation is absorbed by the insurance company. However, annuities generally involve more fees and penalties than bonds. 
  
  
• CDs — Certificates of Deposit (CDs) are offered by banks and insured by the FDIC. Interest earnings on CDs are taxed as interest is earned, so they don’t offer tax-deferred growth as fixed annuities do. Like bonds, CDs offer a return, but not a guaranteed lifetime income stream. 

How to choose the right fixed annuity 

Even if you have narrowed your choice down to a fixed annuity, there is still additional research to be done in order to select the best annuity for you. It may be helpful to engage a financial professional in this process. Here are some factors to consider when making your decision:

• Payout options — Depending on the provisions of the contract, payout may occur for a specified number of years or until your death. Choose a payout option that matches your retirement needs.
  
  
• Fees — Annuities typically come with a number of fees. It’s important to understand these fees and when they must be paid. Some common expenses associated with fixed annuities include administrative and surrender fees.
  
  
• Riders — Some annuities may come with an option to purchase riders, which give you the ability to “add on” certain provisions to an annuity. For example, you may be able to add a rider for cost-of-living adjustment, a provision which increases payments over time to account for inflation. Long-term care riders may also be available to help pay for healthcare costs should the need arise. Choosing the right riders can help ensure your annuity meets your particular long-term needs.
  
  
• Company ratings — You’re depending on the life insurance company issuing the annuity to deliver on their promise to make future payments to you based on your annuity contributions. Take some time to evaluate the company’s ratings and research customer satisfaction ratings before choosing an annuity provider. 

Frequently asked questions about fixed annuities

In summary, here are some common questions about annuities to understand how they work at-a-glance.

What is the difference between a fixed and variable annuity?

Fixed and variable annuities differ in the level of risk and return they provide. A fixed annuity provides a guaranteed, stable rate of return and predictable payouts, whereas a variable annuity's value varies with market performance, offering higher potential returns but also a greater risk of loss.

What does a fixed annuity offer protection against?

Investing in a fixed annuity offers you protection against market volatility. Once you make the required either lump sum or regular, ongoing contributions (depending on the terms of the annuity contract), the insurance company agrees to make regular payments to you for the specified period or up until your death. This protects against the loss of savings that may take place in a regular retirement account where funds are invested in the stock market and gain and lose value based on market performance. If you choose a payout option through end of life, fixed annuities can also protect against running out of money before your death.

What happens to my fixed annuity if I pass away?

The provisions of the particular annuity contract dictate what happens to a fixed annuity after your death. Your designated beneficiary will receive the contract’s accumulated value upon your death, as a lump sum or payments over time. Certain return of premium options pay the total premiums paid or the contract value (whichever is greater).

Can you cash out a fixed annuity?

It is possible, but not necessarily advisable, to cash out your fixed annuity. You will likely pay surrender charges, fees and penalties, in addition to being subject to taxes on earnings. With some annuities, it may be possible to take a loan against the cash value. Check the provisions of your annuity contract to understand your options.

Do you pay taxes on annuities?

Annuities grow tax-deferred, meaning that you don’t owe taxes until distribution payments are made. Those payments are taxed at your ordinary income rate at the time that you receive the payments.

What should I consider when choosing a fixed annuity?

When choosing a fixed annuity, it’s important to carefully consider provisions like payout duration, fees and expenses, available riders on the annuity, and the issuing life insurance company’s ratings and reputation. Consult a financial professional for some help wading through the details and identifying which option may be best for you.

Read more about planning for retirement.

*Annuity payments from a tax-qualified plan will be fully taxable as ordinary income. Annuities are intended as vehicles for long-term retirement planning, which is why withdrawals reduce an annuity's remaining death benefit, contract value, cash surrender value and future earnings. Annuities also may be subject to income tax and, if taken prior to age 59 ½, an additional 10% IRS tax penalty may apply.

Disclosure:

All Learning Center articles are general summaries that can be used when considering your financial future at various life stages. The information presented is for educational purposes and is meant to supplement other information specific to your situation. It is not intended as investment advice and does not necessarily represent the opinion of Protective or its subsidiaries. 

Learning Center articles may describe services and financial products not offered by Protective or its subsidiaries. Descriptions of financial products contained in Learning Center articles are not intended to represent those offered by Protective or its subsidiaries.

Neither Protective nor its representatives offer legal or tax advice. We encourage you to consult with your financial professional and legal or tax adviser regarding your individual situations before making investment, social security, retirement strategy, and tax‐related decisions. For information about Protective and its products and services, visit www.protective.com.

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